Toronto-based home Capital Group Inc. is counting on its aggressive business strategy to propel earnings growth of 20% annually for the next several years.
That’s quite a change from only a year ago, when analysts had predicted the company would no longer grow at that rate, because of both its size and the maturity of its core alternative mortgage business.
But Home Capital has no intention of being satisfied with mere organic growth. Instead, says a Sept. 20 report from Toronto-based Dundee Securities Corp. , Home Capital is in the process of transforming itself “from a leading niche player in the non-prime mortgage market to a broader-based Canadian financial services company.”
Home Capital is doing this by expanding aggressively into new lines of business. Late in 2006, it expanded into commercial mortgage loans. Then, in June, it appointed a chief investment officer whose mandate is to start a family of mutual funds. And, in September, it acquired Toronto-based Payment Services Interactive Gateway Corp., which provides VISA credit card processing services to North American merchants for transactions in which the credit cards aren’t present, such as payments over the Internet.
Home Capital has also been taking advantage of the collapse of the Canadian asset-backed commercial paper market — in which it was not involved — by picking up books of mortgages that had been securitized through ABCP. By mid-September, Home Capital had acquired more than $100 million of these mortgages.
This has been reflected in the price of its shares, which were trading around $35 a share in early October. The shares had dropped to $25 in November 2006 and have since recovered some lost ground, but are still not back to their November 2006 high of $43 a share. As of March 1, there were 34.5 million shares outstanding, with Home Capital president and CEO Gerald Soloway holding 7.3% of those shares, and director John Marsh, 4.3%. As of Oct. 31, 2006, Toronto-based Franklin Templeton Investments Corp., through its funds, owned about 12.8%.
Dundee has rated Home Capital as a “market outperform,” with a 12-month target price of $43 a share. Even with a more moderate Canadian housing market, Dundee believes Home Capital’s “entrepreneurial spirit” will continue “to enable the company to extend its solid track record for above-average growth and profitability.”
Home Capital has delivered good profitability. Net income for the six months ended June 30 was $43.2 million, up 40.7% from $30.7 million in the same period a year earlier. Revenue was up 29.1% to $93.6 million from $72.5 million. The efficiency ratio (non-interest expenses as a percentage of revenue) was 26.9%, down from 30.7%. As of June 30, the 12-month trailing return on equity was 28.9%; assets were $4.3 billion with no long-term debt.
Home Capital’s efficiency ratio is the best among 14 Canadian publicly traded deposit-taking institutions. As a result, the company generates a similar amount of net income as that of Montreal-based Laurentian Bank of Canada, which had net income $43.8 million in the six months ended July 31. Laurentian has more than three times the revenue and more than four times the assets, but its efficiency ratio was 73.2%. Home Capital maintains its strong efficiency ratio because it operates in only a few markets, all of which are very profitable.
Here’s a closer look at Home Capital’s businesses:
> Residential Mortgages. Net income for this business was $30.2 million, or 70% of the company’s net income in the first six months of 2007. That was up from $22.5 million a year earlier, partly because of fee increases in late 2006.
Home Capital added $1.2 billion worth of mortgages in the six months, vs $931 million in the same period a year earlier. There was $3 billion in residential mortgages and $195 million of other mortgages on the company’s balance sheet as of June 30.
The company expects this business segment to continue to grow organically. It isn’t looking to acquire other companies, but will pick up books of mortgages as they become available in the fallout of the ABCP turmoil.
Although Soloway admits that year-over-year increase in house prices have come down dramatically in all provinces, he has no worries about serious drops in values. The economic fundamentals in Canada, including affordable interest rates and high employment, are supporting the market, he says.
@page_break@Interestingly, Home Capital saw a dramatic increase in August in the deposits it uses to back up its mortgages and other lending activities. Soloway puts this down to a “flight to quality” in the wake of the ABCP market collapse. He theorizes that investors preferred the security of the GIC deposits Home Capital offers vs mutual funds or direct investments in equities.
Home Capital securitizes virtually all of its mortgages, but not with ABCP. It uses Canada Mortgage and Housing Corp.’s mortgage-backed securities program.
Dundee sees plenty of opportunity in the fallout of the ABCP mess for Home Capital to pick up more books of business. Companies such as Home Capital can cherry-pick less risky mortgages, Dundee says, and also points to reduced competition in the non-prime market as new entrants are deterred from entering the market unless they have diverse sources of funding.
Home Capital had $78 million in second mortgages on its books as of June 30. These are available to customers whose credit rating qualifies them for mortgages under traditional criterion.
> Visa. Home Capital offers VISA credit cards for people with credit problems. The company issues secured cards for which customers deposit $500-$5,000, on which they receive interest, and which becomes their credit limit. The firm also offers a Home Trust Equityline VISA card, which is secured by home equity, with limits of $10,000-$250,000
Home Capital expects this business segment to grow by more than 20% a year for the next three to five years. In five to eight years, it could be as profitable as residential mortgages.
Credit card receivables were $284 million as of June 30 and there was another $7.5 million in personal loans. Net income for the business segment was $7.3 million for the six months, vs $4.2 million for the same period a year earlier. Although that’s only 17% of total net income, Soloway maintains the VISA business could become as big as its mortgage business.
The acquisition of PSiGate, which should be completed early in the fourth quarter, adds another dimension to Home Capital’s VISA business. PSiGate’s current business in the “card not present” niche will continue, and Home Capital plans to add “point of sale” operations. Soloway believes this has big potential because about 20% of merchants are “underserved or not served at all” by VISA.
> Commercial Mortgage Loans. This area is also not fully served, Soloway says. Home Capital added $106 million worth of mortgages in this new business segment in the first six months. Soloway expects outstanding loans could be about $400 million by yearend 2007. It could account for 10%-15% of Home Capital’s business in a couple of years, he adds.
There are four kinds of commercial mortgage loans that Home Capital offers: mortgages on commercial real estate, construction mortgages, inventory mortgages for builders backed by unsold homes, and “warehouse” mortgages. The last one is for other lenders; Home Capital provides a line of credit so that the lender can fund mortgages and warehouse them until there’s a critical mass, at which point they are sold.
> Investment Management. Jason Donville joined Home Capital in June as CIO, with a mandate to build a family of mutual funds. He is starting with a small fund that invests in financial services companies. The minimum investment is $150,000, but he expects to raise $15 million-$20 million from eight to 12 investors. The fund will be “long” only and will charge performance fees.
Donville is testing potential portfolios and will start investing only when he’s satisfied that he has the right mix of companies. That will be late this year.
This approach is in line with the company’s philosophy of gradually building businesses. Donville plans to build a track record and test all the components required for running mutual funds, keeping the risk and the commitment of capital small. When the mutual fund family is established, it will consist of core fixed-income, Canadian equities and global equities.
Soloway says this business could eventually be as big as mortgages and VISA for Home Capital. IE
Home Capital Group readies for extended period of growth
The non-prime mortgage lender is extending into other areas of business to become a broader-based financial institution
- By: Catherine Harris
- October 15, 2007 October 15, 2007
- 13:18